Case 026Asset-backed, project and real-asset lendingWarm up

Ushmita Auto Parts can discount its invoices on a trade receivables platform at 8.5% a year, or accept its buyers' offer of a 2% discount for paying on day 10 instead of day 60. Which is cheaper money?

The situation

Ushmita Auto Parts sells brake assemblies to two vehicle makers on 60-day credit, about Rs 600 crore a year in invoices of roughly Rs 10 crore each. Its bank cash credit costs 10.5% and is nearly fully drawn.

Two ways to be paid sooner are on the table. The buyers will pay on day 10 if Ushmita takes 2% off the invoice. Or Ushmita can upload the accepted invoices to a trade receivables discounting platform, where financiers bid to buy them; the best bid is a discount rate of 8.5% a year for the 60 days.

Your task

Express both routes as an annual rate, say which is cheaper and by how much a year, and explain why the platform can be cheaper than Ushmita's own bank.

Quick check

Giving up 2% to be paid 50 days early costs about what, as an annual rate?

Worked solution

Try it on paper, then open one step at a time.

30-second answerThe answer to give first

The platform is far cheaper: about 8.6% a year against about 14.9% for the early payment discount. Giving up 2% to be paid 50 days sooner is borrowing at roughly 15% a year. On a Rs 10 crore invoice the discount costs Rs 20 lakh; the platform costs about Rs 12 lakh for the same 50 days. Across Rs 600 crore of sales that is about Rs 5.0 crore a year.

Step 1Why is a 2% discount a loan at all?

Picture a tenant offered 2% off a year's rent for paying twelve months ahead. The discount is the landlord paying interest on money received early. An early payment discount is the seller borrowing from its own customer, and the discount is the interest. Ushmita receives Rs 9.80 crore on day 10 instead of Rs 10 crore on day 60. It has borrowed Rs 9.80 crore for 50 days and repays Rs 10 crore, which is interest of Rs 20 lakh.

The relationship
r=d1−d×365t=0.020.98×36550≈14.9%r = \frac{d}{1-d} \times \frac{365}{t} = \frac{0.02}{0.98} \times \frac{365}{50} \approx 14.9\%
dthe discount given up, 2%
1 - dthe share of the invoice actually received, 98%
tdays the cash arrives early: 60 minus 10, so 50
What it says in wordsDivide what you give up by what you receive, then scale the 50-day rate up to a year.
One Rs 10 crore invoice, three ways to be paidday 0day 10day 60Wait for the buyerRs 10.00 cr, full price, cash on day 60Take the 2% discountRs 9.80 cr, Rs 20 lakh given up for 50 daysDiscount on the platformRs 9.86 cr, Rs 14 lakh for 60 days
Taking the discount turns a Rs 10 crore invoice into Rs 9.80 crore on day 10, so Ushmita pays Rs 20 lakh to have the cash 50 days early; the platform pays about Rs 9.86 crore on day 0 for a charge of about Rs 14 lakh.
Step 2How do the two routes compare on the same footing?

Put both on an annual rate. The platform's 8.5% is a discount rateA rate applied to the face value of an invoice and taken off up front, so the borrower receives less than face and the true yield is slightly above the quoted rate.: it charges Rs 13.97 lakh on Rs 10 crore for 60 days and hands over the rest, which works out to 8.62% on the money received. The early payment discount costs about 14.9% a year simple, 15.9% compounded, against 8.6% on the platform. For the identical 50 days the platform would charge about Rs 11.6 lakh against the discount's Rs 20 lakh, a saving of Rs 8.4 lakh an invoice.

What each route to early cash costs, per cent a yearPlatform discounting8.5% quoted, 8.6% effectiveOwn bank cash credit10.5%, priced on Ushmita2% for paying 50 days early14.9% simple, 15.9% compounded0%5%10%15%The discount looks small because it is quoted per invoice, not per year
Platform discounting costs 8.5% quoted and 8.6% effective, Ushmita's own cash credit 10.5%, and the buyers' early payment discount about 14.9% simple or 15.9% compounded, the dearest of the three.
Step 3Why can the platform lend to Ushmita more cheaply than Ushmita's own bank?

Because the platform is not really lending to Ushmita. The invoice has been accepted by the buyer, so the financier's money comes back from the vehicle maker, a far stronger credit than a mid-sized parts supplier. Receivables discounting prices the buyer's credit, not the seller's, which is how a small supplier borrows at a big customer's rate. The limitation is equally plain: the route only works for invoices a strong buyer has accepted on the platform, and it does nothing for sales to weaker customers.

Close with the view and the number. Across about 60 invoices a year the saving is roughly Rs 5.0 crore, money that currently leaks away as 2% here and 2% there. A lender reviewing Ushmita would also notice that its receivables shrink either way, so the bank line it relies on gets headroom back. Before switching, confirm the platform's fees and any charges on the buyer's side, since a flat fee per invoice adds to the effective rate on small invoices.

Where candidates lose it

The common slip is comparing 2% with 8.5% and calling the discount cheap. One is a per-invoice charge for 50 days, the other is a yearly rate. Until both are annualised they cannot be compared.

The second slip is using 60 days in the denominator. The buyer still pays on day 10, so the cash arrives 50 days early, not 60, and the discount costs more than a 60-day calculation shows.

What the interviewer asks next

  • At what discount percentage would the early payment offer cost the same as the platform?
  • One buyer refuses to accept invoices on the platform. What does that do to the plan?
  • Why might the buyer prefer Ushmita to use the platform rather than take the discount?
  • How would a bank reviewing Ushmita's cash credit read a fall in receivable days caused by discounting?

Company names and figures are illustrative.